LATIN AMERICA’S LESSONS FROM CAPITAL ACCOUNT LIBERALIZATION

1. LATIN AMERICA’S LESSONS FROM CAPITAL ACCOUNT LIBERALIZATION José Antonio Ocampo and BilgeErten Committee on Global Thought Columbia University "Capital Account Liberalization in China: Learning Lessons" Workshop Boston University– February 13, 2014

2. Medium-term cycles of capital flows to emerging markets: 1. 1975-81--Recycling of petrodollars, via bank loans, to oil-importing EMs 1982, Aug.-- Mexico unable to service its debt on schedule, defaults => Start of the Latin American debt crisis, 1982-89 1990-97-- New capital flows to EMEs following 1989 Brady Plan 1994, Dec. -- Mexican peso crisis1997,July-- Thailand forced to devalue and seek IMF assistance => Start ofEast Asia crisis1998, Aug. -- Russia defaults on much of its debt => Contagion to Brazil.2001-02 -- Turkey and Argentina currency & debt crises 2003-07 -- New capital flows into developing countries 2008, Sep. – Lehman Brothers collapse => Beginning ofNorth AtlanticFinancialCrisis 2009-13 -- Post-crisis surge in capital flows to emerging markets, 2013, May -- May 2013 U.S. Fed taperingbegan the contraction phase 2. 3. 4.

3. Net resource transfers to Latin America Source: Authors’ estimates based on ECLAC data

4. Major phases of liberalization and regulation 1. 1950-75 -- Extensive FX and capital account regulations in all LA • Exceptions: Mexico and Venezuela 1975-81-- Capital account liberalizationin Argentina, Chile and Peru, but Brazil and Colombia remain relatively closed; Domestic liberalizationin Argentina and Chile • 1982-89 -- Closing of the capital account during LA debt crisis 1990-98 -- Broad-based capital account liberalization in LA, including Brazil and Colombia, but with new instruments to regulate capital flows: • Taxes on capital flows in Brazil, and URRs in Chile and Colombia. • Regulations on FX transactions, e.g. restrictions on domestic financial deposits in FX. -- Semi-dollarized systems in Argentina and Peru, hyperinflations of 1989 and 1990; but not in Brazil despite its hyperinflation in early 1990s 2000-06-- Further liberalization in Brazil, Colombia, Chile(FTA with U.S.), but reversal of liberalization in Venezuela and Argentina • 2004-13 -- Peru used differential RRs on deposits in dollars and short-term external borrowing by domestic banks vs. deposits in the domestic currency • 2007-08 -- Colombia used URRs before FTA with U.S. • 2009-11 -- Brazil used taxes on capital inflows after the North-Atlantic crisis 2. 3.

5. Comparison of capital account restrictiveness of Latin America vs Emerging Market Economies

6. Capital flow regulations in Latin America

7. Lessons from capital account liberalization and regulation • Surges in international capital flows generate pressure to adopt pro-cyclical macroeconomic management and to liberalize capital account and financial regulations, with large destabilizing effects: • Both the liberalization of the 1970s/early-1980s and that of the 1992-97 ended up in major crises. • However, not all booms end up in crises: The critical issues are current account deficits and associated currency appreciation. • Reduction of external debts and accumulation of reserves serve as additional buffers against capital flow volatility. • The domestic counterpart of the current account deficit is important: the experience of the Southern Cone during the first boom and of a broader group of countries during the second was problematic, since external financing was essentially consumed. • Maintaining some capital account regulations to directly manage capital flow volatility is important. • Brazil, Chile, Colombia and Peru used some of these tools effectively. • But these regulations should be used as a complement, not as a substitute for domestic financial regulations – in some cases, their use as a substitute has made crises unavoidable and more severe.

8. Investment as a share of GDP Source: Authors’ estimates based on ECLAC data

9. External debt as a share of GDP Source: Authors’ estimates based on ECLAC data

10. Current account balance has deteriorated since 2002 when adjusted by terms of trade Source: Authors’ estimates based on ECLAC data

11. LATIN AMERICA’S LESSONS FROM CAPITAL ACCOUNT LIBERALIZATION José Antonio Ocampo and BilgeErten Committee on Global Thought Columbia University "Capital Account Liberalization in China: Learning Lessons" Workshop Boston University– February 13, 2014